We have all seen it. A startup has initial success with an innovative business concept, an early product, a first or second round of capital and a spurt of revenue growth. Then suddenly, its momentum stalls.
More than 50% of all venture-backed companies in the past decade with $10 million in sales never made it to $20 million. The problem is as acute now as it has ever been and the bar for exits high.
Few of these walking dead are highlights of the Monday morning venture partners’ meeting. It is the “hot” firms or the “sinking ships” that get all the attention, not the stalled companies with money in the bank and the ability to support themselves on $10 million in revenue. After all, stalls are temporary, right?
Yet the issue is a huge one given the substantial value locked up in stalled companies. Symphony Technology Group and Trilogy found ways for managing in the enterprise software market by consolidating assets and reenergizing growth. On balance though, it is extremely rare that stalled venture assets deliver a meaningful return. In most cases, stalled technology and media companies quickly bleed out talent as the best brains end up elsewhere. That’s Silicon Valley culture.
People like to pursue the big ideas and follow the big bucks.
This makes recognizing stalls early, identifying their causes and reversing the insidious value destruction a key part of managing any venture portfolio. Unfortunately, many VCs aren’t very good at it. At Spoke, we spent a long time stalled and focused on the wrong metrics. With significant venture money in the bank, Spoke followed an ineffective business model. Sales costs ate up capital for years. A number of the best and brightest left and went on to create billions of market value at Topix, 4info, BrightRoll, Facebook, Guidewire, MerchantCircle and Quantcast. A bold move earlier would have given Spoke a shot at LinkedIn-type returns.
It is not simple. Venture backed companies stall for many reasons. Often, the underlying reasons are related to:
- Market timing and business cycles. The post-Lehman financial crisis has taken its toll, particularly in communications-related segments.
- Capital constraints. Tired investors hold companies back by playing to not lose instead of playing to win. This has become an unfortunate and pervasive reality.
- Business models. Companies often are slow to change their business models to enable continued, capital-efficient growth. Once through the proverbial “bowling alley”, most company’s need to re-invent themselves operationally.
- Technology cycles. Innovation never stops, so ignoring fundamental trends and going into “maintenance mode,” or under investing in what really matters, will render companies obsolete, quickly.
- Ignoring leadership and talent. The good ones will be gone in no time, making a company a hollow shell, unless they are given a mandate to win.
Once you know you have a stall, the worst thing you can do is to simply wait it out or try more of the same, strategically and operationally. The only way to right the ship is through comprehensive and decisive action. Hands-off management or “fly-by” board-level governance will simply perpetuate the problem and destroy value.
- Understand the issue. Procure feedback from folks who have a strong opinion and are not afraid to state it. Don’t over analyze. Apply the 80/20 rule. Show leadership, commitment and a willingness to change.
- Renew and redefine the organizations’s focus. Startups need to do one thing exceptional well in order to maintain their energy and create value.
- Check your team. Quickly get rid of folks married to the “old” ways. Augment where required. Make sure to align interest through stock. This may involve allowing for small secondary stock sales to create some liquidity for management and founders.
- Reduce spending. Cut 15% more than what you think you should and immediately start hiring new talent. A new vision will allow you to get the best. Do away with any idle, unfocused capacity.
- Reinvent. Be willing to divorce the company from legacy assets to hone focus. Or conversely, merge with new assets and capabilities to reignite growth. The aim is to capture better long-term exit value, even if it means shaking up the cap table.
- Commit yourself. If you are not prepared to solve the problem as an investor, get someone in your position who will. A new round or secondary transaction can be the means. It is hard work. It carries risk. Often it requires new faces around the board table.
Obviously, dishing out structural advice is easy. Putting it into practice is often difficult, and we’ve had it wrong more than once. But we feel we got it right recently. The company was a market share leader in a sophisticated media vertical and was stalled due to the level of market share it held in a limited infrastructure segment. When the company pushed for growth, it brought increased customer fragmentation, accounts receivable risk and price erosion.
This is how the stall was addressed:
- The decision was taken to milk the legacy business and cut back aggressively on resources deployed there. The best resources were focused on developing a platform with broader vertical appeal.
- The internal efforts were augmented and accelerated by a merger with a company that had a complementary offering and substantial intellectual property.
- A new bowling alley was defined. The best business development and sales guys were given incentives to form new partnerships more broadly accessing the market. A key was the first major account-win with the new platform.
- Investors pitched in – some more some less. The board now favors the new money and direction. More capital is under consideration.
It took time, though less than some of the investors had expected. Early results are good. The company increased bookings by more than 30% last year.
So for those of you with walking dead, go fix them, even if it feels risky. If you don’t you are sure to destroy value over time.
(Dr. Maximilian Schroeck (top photo) is a managing partner at Cipio Partners and serves on the boards of various telecommunications, media and technology companies. He is a former Agilent executive. Ben T. Smith IV(second photo) is a serial entrepreneur, investor and the co-founder of MerchantCircle.com and Spoke.com. Both were former partners at A.T. Kearney. Ben is available on Twitter @bentsmithfour.)